Your profits in the Forex market are based on the small movements in the price of a currency pair you own. You are basically betting that a particular currency will gain or lose value compared to another. If you bet right, you can make a lot of money very quickly. The challenge is that this change in price can be very small and you’ll need to have a lot of the currency under your control to profit from these tiny fluctuations. To help increase your profits, most Forex brokers will offer you leverage for your trades that can help to magnify the size of your position compared to your actual investment.
More Leverage The Longer You Trade with a Broker
The leverage a broker will provide depends on a few factors and most will increase the amount they offer you over time as you trade more often and they get to know you as a client. Standard leverage for most new accounts is 50:1 or 100:1. Larger or more mature accounts may be offered 200:1 or even 500:1 with some brokers. The risk for the broker is relatively minor because the fluctuation in currency pairs is normally small. The advantage to the brokers is that they make more on their commissions for the trade because their fee is based on the pips you purchase. By offering 100:1 leverege they increase their fee by 100 times so a trade that might have netted them 5 cents for each pip is now worth $5.00 a pip and their overall compensation is much higher.
There Is Danger in Using Too Much Leverage
There is a downside to using too much leverage since it not only increases your profits, it can also magnify your losses. Most Forex investors that trade with leverage will prevent larger losses by using a combination if limit and stop orders to minimize their downside. By setting an emergency exit point with one of these trading tools, you can be sure to use any leverage your Forex broker extends to you to only increase your earnings.
How to Use Leverage Responsibly
The real key to using leverage responsibly is in knowing what you are willing to lose with every investment you make. By defining this number for your trades in advance of investing you can create a strategy to use the leverage provided by your Forex broker to your advantage. For example, you may be willing to lose 3% on an investment and will need to place a stop loss at that level to make sure you exit when your limit is reached. On a $10,000 investment this would be at $300. The challenge is that if you place the stop loss at exactly $300 you might dip below that threshold just before the currency rebounds and miss the profit. Most experienced Forex traders will check the history of the currency they are trading to see if this type of pattern is common. If it is they will normally set the stop loss a little lower than their threshold to give it a chance to recover before exiting the position.
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